Getting a raise can be great for your finances — and for your quality of life. It might allow you to pay off debt, invest, or finally get rid of that old radiator in your home that sounds like something straight out of a horror movie.
That doesn’t mean getting a raise is always a good thing, though. If you aren’t careful, it can lead to making costly financial decisions that could even make you worse off in the long run.
1. You Buy More Expensive Houses and Cars
Most of us have to pay for our housing and transportation, and there are nearly endless options for both. Thus, when you find yourself with a bigger paycheck, you might think it’s time to upgrade your home or your car. You might consider it because you can afford it now, or you believe you deserve it, etc.
The problem here is that you may not be thinking about the entire cost of more expensive homes and cars. For one thing, you are probably going to be financing both of them. And when you take out a larger loan, you tend to pay more, not just in terms of the sticker price, but also in terms of interest.
The interest is the real problem: if your mortgage increases by 50%, for example, you’ll pay more than 50% additional interest over the life of the loan.
Plus, more expensive homes and cars have higher ongoing costs. Bigger homes mean paying more in property taxes, and in both cases, your insurance rates will probably be higher.
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2. You Fall Victim to Lifestyle Inflation
This point is related to the previous one, but it’s worth stating separately. If you get a big enough raise, it can cause your view of your financial situation to shift from one of scarcity to one of abundance.
Of course, it’s a good thing to feel like you no longer have to pinch every last penny. But if you take things too far to the other extreme — spending money without a care — you could still find yourself living paycheck to paycheck. It’s okay to buy fancy dinners and nice clothes every now and then, but that doesn’t mean it should be the norm.
The moral here is that while it’s okay to treat yourself, you should still aim to live below your means. Doing so will allow you to keep saving and investing for the future.
3. You Rely Too Heavily on Credit Cards
Credit cards have a lot of benefits these days, such as cash back and generous travel rewards. You might think, with your higher income, you should be taking advantage of these perks. And while they can be nice, credit cards can be dangerous if you don’t properly budget for them.
The key is to be sure you have the budget to pay them off. Just because you are making money, that isn’t guaranteed. Credit cards have high APRs, and failing to pay them off will likely hurt your credit score and cost you more in the long run.
Thus, even though you got a raise, you shouldn’t rely too heavily on them if you don’t have the budget for it.
4. You Make Risky Investments
Now that you are ready to start investing, how do you go about it? If your answer is buying stocks like Gamestop and AMC on Robinhood, you may want to think again. While it’s OK to allocate a small percentage of your portfolio (a few percent) to speculative stocks, most of your money should be going into low-cost index funds.
Index funds don’t eliminate risk completely, but they tend to perform well compared to the risk level. Thus, they are one of the best ways to build wealth over time.
5. It Puts You in a Higher Tax Bracket
Getting a raise means your income will be higher, and that could mean you end up in a higher tax bracket. For 2022, the 12% tax bracket for single filers goes up to $41,775, and the 22% tax bracket goes up to $89,075. Having a higher income can increase the percentage of your income you pay in taxes.
Fortunately, you aren’t taxed the same rate for every dollar you earn. Instead, you are only taxed for each dollar you earn in that tax bracket. For example, if you make $41,776 in 2022, you only pay 22% tax on $1; the rest of your money is taxed at the 12% rate.
This is why reducing your taxable income is a great idea. One way to do that is by increasing your contributions to a tax-deferred retirement account, such as a 401(k) or traditional IRA. Combine that with low-cost index funds and you’ll be on the right track.
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